Marijuana ETFs: 3 Biggest Challenges

By admin_45 in Blog

One of the questions we most commonly hear about investing in the legal marijuana industry is why aren’t there more US-listed exchange traded funds to choose from? The short answer is that they are very difficult to launch because cannabis is still federally illegal in the US and classified as a Schedule I drug along with the likes of heroin.

That said, there’s been an increasing number of marijuana-based ETFs debuting this year. One is called The Cannabis ETF (THCX) by Innovation Shares, which listed on the NYSE last month. Our friend and Managing Director at the firm, Matt Markiewicz, (also a DataTrek client) was kind enough to take the time and tell us what it took to get THCX off the ground.

Our primary question to Matt: what were the three biggest obstacles you faced? Here were his answers, paraphrased in our own words:

#1 – Finding a custodian for the fund. Most banks or broker dealers have been unwilling to custody cannabis shares because they do not want to risk violating federal banking laws since marijuana is federally illegal. Without a custodian willing to hold marijuana shares for a cannabis ETF, it’s the end of the road for a prospective issuer. Additionally, it is tough to sign up a fund administrator – who determines the NAV of a fund, for example – for the same reason. 

Matt had to approach upwards of 20 banks/broker dealers just to find one that would act as his fund’s custodian. He received a mix of answers from the other 19: some said no outright, while others said they would need to put it through their internal review process (after which they were unable to move forward). Some were actually willing, but lacked the proper operations in place that acting as a custodian of a fund requires such as the daily create and redeem process. In this case, they were open to building out their service model necessary to support such a product, but it would take a year which was too long.

Overall, the bad news: finding a custodian is hard. The good news: there are now at least few marijuana ETFs, such as THCX, that show it can be done.

#2 – Lack of eligibility on widely used investment platforms. Many platforms, such as at the major wirehouse firms, ban marijuana ETFs because of the drug’s national illegality. That means an advisor can’t buy marijuana ETFs at those firms even if their clients ask. The best chance of getting on certain platforms is by meeting steep asset hurdles within a short time frame. Otherwise, they are blocked for reasons given everything from 1) there are not enough marijuana ETFs to compare, 2) the history of them is too short, and 3) the universe of potential buyers is too limited. 

The upshot: marijuana ETFs cannot advertise or be on many large platforms, a major impediment to asset gathering for these funds. This is in large part why marijuana stocks and ETFs are typically traded by retail investors and hedge funds.

#3 – Shortage of education among investors. Since the legal marijuana industry is so new, cannabis stocks and the market as a whole are under-covered by most research analysts and investment banks. The industry itself is also highly complex, as regulations differ by state. Investors need to learn a new business model and how these companies will actually make money with little guidance.

Moreover, marijuana is a polarizing issue politically. In Matt’s experience, he has found that many advisors are hesitant to bring up a marijuana ETF to their clients because they do not know what type of a response they will receive. Many people have different experiences with marijuana, either good or bad, and the latter can often elicit negative reactions.

Bottom line: it took Matt and his firm several more months than usual to launch THCX. There are many more regulatory obstacles and longer review processes to overcome than a typical ETF. It’s not impossible, but important to know the challenges to understand the dearth of marijuana ETFs in the space.